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Broadcom Powers Higher

Beaten down Broadcom powers higher on hopes that its cellular efforts will finally pay off.

When shares of Broadcom(NASDAQ:BRCM) fell, they fell hard. The company's guidance fell flat and it was revealed on the call that meaningful LTE revenues from its very expensive cellular baseband effort wouldn't be ready until the second half of 2014. The shares were pummeled that day, cratering from about $34 per share to $27 – a whopping 21% -- in just a day. After further pain (the shares printed $23.25 before the worst was over), the shares began to rebound – and for good reason.

Broadcom is in a really good positionBroadcom is in a pretty good position within the semiconductor industry. It has good exposure to network infrastructure/communications that benefits nicely from the insatiable demand for cellular data. It has a great broadband business that isn't extremely high growth, but it is growing in low- to mid-single digits and is extremely profitable. Finally, Broadcom's exposure to the explosion in mobile devices by way of its connectivity combo chips is nothing to sneeze at – it's healthy, growing, and profitable.

Yes, the market freaked out when the cellular efforts – which are viewed as both strategic (to defend connectivity market share) as well as growth-oriented (since Broadcom's exposure to cellular baseband is not particularly high) – weren't progressing as expected. Shortly thereafter, Broadcom announced that it would be buying Renesas Mobile in order to accelerate its LTE efforts.

So far, so good – but the proof is in the puddingAt Broadcom's analyst day, management laid out a very compelling plan to capture share in the high end part of the handset market with its LTE-Advanced slim modem as well as at the low end with its integrated platform solutions. Of course, management has never been short on promises in cellular – it's the execution and delivery that have proven to be the issue. If the company actually follows through on the plan that was laid out, then the shares could go much higher throughout the year.

However, Qualcomm(NASDAQ:QCOM) – the current market leader in all chips mobile – isn't going to lose sockets in cellular quietly (just as Broadcom has done a very good job of defending connectivity share). Its product lineup in all things cellular is absolutely superb, spanning the highest of the high end to the lowest of the low end. While Broadcom announced a couple of wins (including a Samsung phone) for its next generation LTE + apps processor solution, it's going to need to do a lot more than that to really win over the hearts of Wall Street.

Can Broadcom really succeed?That's the multi-billion dollar question – can Broadcom ultimately succeed in the mobile chip space or will it eventually need to bow out as TI did a while back? There's no way to know with a high degree of certainty. The investments required here are massive and will only get more difficult over time – and only the few that can afford it (defined as seeing adequate return on invested capital). Qualcomm is, unless something goes horribly wrong, very likely to survive long term. Intel (NASDAQ:INTC), another major competitor here, is also likely to be here as its long-term future depends on it (and it has a number of special advantages-such as a manufacturing advantage and R&D leverage- that none of the other players quite possess).

But Broadcom is in a unique position. It could jettison its cellular efforts and, in fact, sell its entire mobile and wireless division and still have two very profitable, very viable businesses. The potential growth profile wouldn't look nearly as attractive and the company would be much smaller, but it would survive, thrive, and possibly command a richer multiple.

That being said, management has made it clear that this upcoming product cycle will give a pretty strong indication of whether the company will continue to play the cellular game. If things go well and the revenue base justifies continued investment, then Broadcom will be a very solid No. 2 or No. 3 (depending on how successful Intel is) in this space. If not, then that money can (and very likely will) be used more wisely elsewhere.

Foolish bottom lineYes, competing with Qualcomm and Intel will be tough, and no, there's no guarantee that Broadcom's cellular efforts will succeed, but the odds look good that the company's efforts will be viable long term. The upcoming product cycle will give the initial sign and then from there, investors will just have to see how it goes. In either case, the company is cheap at less than 10x trailing twelve month free cash flow and after badly underperforming in 2013, the stock could have a much brighter 2014.

Author

Ashraf Eassa is a technology specialist with The Motley Fool. He writes mostly about technology stocks, but is especially interested in anything related to chips -- the semiconductor kind, that is. He can be reached on Twitter -- follow him there: Follow @tmfchipfool